The Effects of Specialist Type and Estimate Aggressiveness on Jurors' Judgments of Auditor Negligence

Abstract

SUMMARY We examine the effects of two critical factors auditors consider when auditing complex estimates, the decision to use a specialist and the relative aggressiveness of management's estimate, on jurors' auditor negligence assessments. Experiment 1 finds jurors view auditors' acceptance of a more aggressive estimate as more justifiable, and are thus less likely to find them negligent, when auditors consult with either internal or external specialists. However, these litigation benefits do not extend to audits of less aggressive estimates. Experiment 2 finds jurors are less likely to find auditors negligent when auditors use an external versus an internal specialist, due to greater perceptions of external specialist independence. We also find auditors accrue similar litigation benefits when an external specialist reviews the internal specialists' work. We conclude that utilizing external specialists, either to directly test complex estimates or to review internal specialists' work, limits auditors' litigation exposure when auditing relatively aggressive estimates. JEL Classifications: M40; M41; M42. Data Availability: Available upon request from the authors.

When Does Utilizing Valuation Specialists Reduce Auditors' Litigation Risk?

“…While not directly hypothesized, the authors also compared the External Specialist condition to the Both Specialists condition, and the difference in Verdict is not statistically significant. Additional Analyses Brown et al (2019) further explore the mechanisms behind Experiment 1 and Experiment 2 auditor negligence verdicts with a series of additional analyses, the results of which are briefly summarized here. Consistent with the use of a specialist constraining juror negligence assessments against the auditors when management's estimate was more aggressive, the study finds that jurors rated the auditors' decision to accept management's estimate as more justifiable when they consulted with a Specialist compared to relying on a Non-Specialist to test management's estimate.…”

“…Overall, these additional analyses provide further support for the theoretical development and highlight how juror perceptions of auditor justifiability and specialist independence are associated with their auditor negligence verdicts. Brown et al (2019) offer important practical insights that could assist audit firms in planning their audits of complex management estimates and in deciding whether to use a valuation specialist to assist with their audit testing. Overall, results suggest that auditors can limit their litigation risk for clients with relatively more aggressive management estimates by choosing to consult with a specialist in this area.…”

“…In response, a growing stream of research explores how specialists can improve audit quality in the audits of complex estimates (e.g., Griffith 2017; Joe, Wu, and Zimmerman 2017b; Pyzoha, Taylor and Wu 2018). Brown et al (2019) extend this literature stream by examining how third-party evaluators, such as potential jurors, evaluate audits of complex estimates and auditors' choice to engage a specialist to assist with audits in this critical area.…”

“…That is, despite jurors' motivation to find auditors negligent for an alleged audit failure, convincing evidence indicating that the auditors exhibited an appropriate level of care can constrain jurors from finding the auditors blameworthy (e.g., Kadous 2000). Brown,Grenier,Pyzoha,Reffett,and Zielinski P2 In the case of an alleged audit failure pertaining to a complex management estimate, Brown et al (2019) use motivated reasoning theory to predict that the auditors' use of a specialist, either internal or external to the audit firm, would signal to jurors that the auditors exercised due professional care in auditing the estimate, thereby reducing jurors' auditor negligence assessments. Additionally, the study predicts that the litigation benefit provided by specialist use would depend on the level of management aggressiveness (i.e., potential bias) included in the estimate.…”

“…A recently published study, ''The Effects of Specialist Type and Estimate Aggressiveness on Juror Judgments of Auditor Negligence'' (Brown, Grenier, Pyzoha, and Reffett 2019), investigates how reliance on valuation specialists affects auditor litigation risk. Specifically, Brown et al (2019) examine whether auditors' choice in engaging with either an internal (i.e., auditor-employed specialist) or external specialist (i.e., auditor-engaged specialist) to assist in auditing a complex management estimate, coupled with differing levels of estimate aggressiveness, influence juror perceptions of auditor negligence in the case of an alleged audit failure. The current article summarizes the previously published study's motivation, the methods and results of its two experiments and supplemental analyses, and the implications to audit firms that face litigation risk when testing complex management estimates.…”